In addition to your credit score, your debt-to-income (DTI) ratio is an important part of your overall financial health. Calculating your DTI may help you determine how comfortable you are with your current debt, and also decide whether applying for credit is the right choice for you.
When you apply for credit, lenders evaluate your DTI to help determine the risk associated with you taking on another payment. Your DTI is a percentage calculated by dividing your monthly gross income with your monthly debt payments. Follow the steps below to discover your own DTI.
Total your monthly bills. Take some time and total up the general, recurring bills you pay each month, like:
- Monthly rent or housing payment
- Monthly child support or other marital debt
- Auto loans, student loans or other monthly loan payments
- Credit Card minimum monthly payments
Remember, payments like groceries, gas, parking, utilities, day care, cable, taxes (if not included in your mortgage payment) are generally not included in your debt-to-income calculation. However, when you sit down to create your budget, be sure to include those items in your expense list.
Divide your total monthly bills by your income. To get your ratio, divide the total of your monthly bills above by your pretax, gross monthly income. This calculation will result in a number that will reflect your DTI ratio as a percentage. For example, if the result of your calculation is 0.325, then your DTI is 32.5% when converted to a percentage. You can also use our DTI Calculator.
What is considered a good DTI ratio? The lower your DTI ratio, the more flexibility you will have in your budget to save, give, make home repairs, travel, etc. Remember, the calculation uses your gross income, not your net income or take-home pay.
- A debt-to-income ratio of 35% or less is considered good and debt should be manageable.
- With a debt to income ratio of 36% to 45%, there may be opportunity to improve your debt structure. You might consider a smaller mortgage to make your debt more manageable.
- A DTI of more than 45% indicates you may need to make some changes. A higher ratio means that you have little availability for funds to address unplanned expenses. This high ratio may affect your approval for a mortgage.
- DTI over 50%: Paying down this level of debt will be difficult, and your borrowing options will be limited. Weigh different debt relief options, including bankruptcy, which may be the fastest and least damaging option.
To recap, your debt-to-income ratio (DTI) is the percentage of your gross monthly income that is spent on monthly debt payments. It’s important, because lenders use it to determine if you’re a good credit risk, and to qualify you for the best interest rates.
Until next time,